Arnold Kling  

The Risk Animal

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Subsidies... Questioning a Talking Point...

Nassim Taleb discusses financial markets and our inability to avoid crises. He describes risk as like a predatory animal that always succeeds in finding the weakest quarry on which to prey. That's the same idea that I try to get at when I say that you cannot make financial markets idiot-proof, because they'll just build a better idiot.

Thanks to Marshall Jevons for the pointer.

I think that it is human nature to be over-confident about one's own beliefs and abilities. As Tyler Cowen and Robin Hanson point out, one of the consequences of over-confidence is disagreement. You and I cannot both be rational, equally informed, and in disagreement. Yet we often are.

Another consequence of over-confidence is excessive risk-taking. In making financial decisions, it might be good to ask oneself, "How can I protect myself from knowing less than what I think I know?"

In Taleb's terms, we should act as if there is a Black Swan out there. Something will happen that we don't expect, because we are over-confident in forming our expectations.


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COMMENTS (6 to date)
nocountry writes:

A great antidote for Taleb:

http://www.efalken.com/papers/Taleb2.html

Adam writes:

I don't normally like to divide people into groups like this, but I think it's male nature, not human nature (risk-taking and overconfidence). I believe that studies have shown that women do better on average at investing in financial markets than men, because they tend to stick much more to a buy-and-hold strategy. What was good for getting a girl on the African savanna 50,000 years ago is not so good for getting rich now.

An interesting question, do women tend to have a smaller amount of overconfidence bias, or do they tend to not have overconfidence bias at all?

Dan Weber writes:

Women tend to be more risk-averse than they should be. Men tend to be more risk-accepting than they should be.

Tierney in the NYT

Most women declined to compete, even the ones who had done the best in the earlier rounds. Most men chose the tournament, even the ones who had done the worst.

liberty writes:

"You and I cannot both be rational, equally informed, and in disagreement. Yet we often are."

If by disagreement, you mean that we don't agree on an objective value, this may be true. However a lot of stock trading is not about objective valuation, but subjective preference.

For example, if I am 67 years old, I may subjectively value a stock differently than if I am 34 -- because at 34 years old, I want to buy it in order to save for retirement, and at 67 I want to sell it in order to pay for my retirement.

Aside from this obvious example, there are also differences in personal taste for risk, and reasons why it makes rational sense for some people to take risk, and others to avoid it. And those are just the tip of the iceberg when it comes to subjective rational reasons for "disagreement" about the subjective value of stocks.

Dr. T writes:
You and I cannot both be rational, equally informed, and in disagreement.
I agree with liberty (above). I also would like to state that two people can be rational and equally informed but disagree because they are discussing projected futures. The two people have different experiences and backgrounds and different ways of using those to make projections.
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